Barry Eichengreen is Professor of Economics at the University of California, Berkeley; Pitt Professor of American History and Institutions at the University of Cambridge; and a former senior policy adviser at the International Monetary Fund. His newest book, Hall of Mirrors:The Great… read more

Europe’s Summer Reading List

BERKELEY – In August, Europeans head for the beach. The continent shuts down on the assumption that nothing of consequence will happen until everyone returns, suitably tanned, in September. Never mind the subprime crisis of August 2007 or, closer to home, the European monetary crisis of August 1992: the August holiday is a venerable tradition. So, what should Europeans be reading beneath their sun umbrellas this year?

Milton Friedman’s and Anna Schwartz’s A Monetary History of the United States belongs at the top of the list. At the center of their gripping narrative is a chapter on the Great Depression, anchored by an indictment of the US Federal Reserve Board for responding inadequately to the mounting crisis.

Friedman and Schwartz are generally seen as reproving the Fed for failing to react swiftly to successive waves of bank failures, first in late 1930 and then again in 1931 and 1933. But a close reading reveals that the authors reserve their most scathing criticism for the Fed’s failure to initiate a concerted program of security purchases in the first half of 1930 in order to prevent those bank failures.

That is a message that the European Central Bank’s board members could usefully take to heart, given their announcement on August 2 that they were ready to respond to events as they unfolded but were taking no action for now. Reading Friedman and Schwartz will remind them that it is better to head off a crisis than it is to rely on one’s ability to end it.

A second recommendation is another account of the crisis of the 1930’s, Charles Kindleberger’s The World in Depression, 1929-1939. (If vacationing officials detect a pattern in their summer reading, all the better.) Kindleberger’s point is that avoiding a crisis – and when failing to avoid one, successfully exiting from it – requires leadership.

Specifically, it requires leadership by a country with the power of the purse and the willingness to use it. The problem in the interwar period, as Kindleberger recounts it, was the reluctance of the leading power, the US, to provide the leadership and financial wherewithal to resolve the crisis.

In Europe today, reunified and reinvigorated Germany is the only country capable of assuming this role. It could agree to swift bank recapitalization, a banking license for the European Stability Mechanism, and a more expansionary ECB policy. If Germany provided this kind of leadership, other countries would be quick to follow. Europe’s crisis would then be well along the path to resolution.

Germans sunning themselves on Greek islands, one hopes, would be inspired by such reading. But it is hard to be confident.

Of course, books by economics professors about the Great Depression hardly a summer holiday make. For variety, European leaders could take along Ron Chernow’s biography of Alexander Hamilton. Hamilton was a colorful character, born out of wedlock, raised in the West Indies, and captain of an artillery company in America’s revolutionary war. More to the point, as George Washington’s Treasury secretary, he crafted the bargain that successfully rationalized the US states’ debts.

US states entered their new union with different debt loads and different capacities to service them. Hamilton made the case that the federal government should assume responsibility for their liabilities stemming from the costs of financing the war. He identified a source of revenue – the tariff – that could be devoted to this end, and he rendered the bargain politically palatable by making clear that if state governments accumulated additional debts, and again got into trouble, they would not be bailed out a second time.

European officials will argue that their problem is more difficult. Not only does Europe lack a federal government, but there is no desire to create one. A close reading of Hamilton’s accomplishments, however, will remind European readers that there was an equally deep aversion to federalism in the early US. It took politicians with vision and diplomatic skills to craft the political entity that emerged after independence.

Finally, European leaders should consider adding to their book bag Barbara Tuchman’s The Guns of August (again, notice the month). Tuchman describes how a series of individual decisions, all of which seemed sound when considered in isolation, had the unintended consequence of leading Europe into World War I.

No one is predicting war in Europe today. But what is true of international diplomacy – that a series of seemingly reasonable decisions can have cataclysmic consequences if no one bothers to figure out the endgame – is equally true of international finance. Europe is dangerously close to its financial Sarajevo. The continent’s leaders, while relaxing on southern Europe’s crisis-ridden shores, should take Tuchman’s message to heart.

Comments

It may be worthwhile to pursue the theme of possible parallels and differences between the Great Contraction episode and the recent financial crisis. Friedman and Schwartz expressed a high level of confidence in the powers of central banking: "Throughout the contraction, the System had ample powers to cut short the tragic process of monetary deflation and banking collapse." (p. 11) They also emphasized the role of strong personal leadership. "If Strong had still been alive..." (p. 412) According to at least one alternative interpretation, which is not incompatible with the monetarist explanation, the Fed was also responsible, from 1922 to 1928, for having set the stage for a boom-bust cycle by drastically expanding the money supply in fear of deflation; from this perspective both episodes present rather neat instances of an almost classic cycle. But after that a host of policy missteps prevented markets from adjusting to changing circumstances, accounting for the unusual depth and length of the Great Depression. And certainly an element of paradox resides in claiming government stimulus programs as the appropriate solution to the very disorder that prior intervention has created.

The books mentioned refer to the 1930s. The big difference between the 1930s and today is that real interest rates were relatively high in the 1930s and very low today. Therefore the policy measurs of Friedman and Schwartz would have prevented a crisis in the 1930s by reducing the real rate of interest to an equilibrium level of 2,5%. The same measures taken today are creating a perfect storm by reducing real interest rates even further. The result is lower saving, lower investment, lower economic growth, higher unemployment and higher debt levels.Therefore we need bold leaders who understand that todays economic and monetary problems differ from those in the 1930s. We need higher and not lower real interest rates in order to get higher economic growth. Didn't Paul Volcker overcome the stagnating economic growth of the 1970s by increasing the real rate of interest?

Let me recommend the last two chapters of Keynes "The Economic Consequences of the Peace." Keynes was one of the first to view Europe as an economic whole and that Germany was the engine of the whole. Keynes provides a brilliant overview with much that is still relevant today.

Another chapter deals with burdening Germany with reparations. Like "taxing the rich," having Germany pay "until the pips squeak" is a populist slogan that does not take you to any useful future economic reality.

As in 1919, all parties must be prepared to make investments in the future of the whole.

Another useful principle is that Keynes saw that new loans were required and that these loans could only be repaid out of future higher economic growth. Punishment rarely repays.

And the old loans? Since there was no income to repay them, they should be written off if for no other reason than that their presence pollutes the political discussion.

I would recommend more recent articles from politicians, economists, scientists of different fields or even well put together video clips widely available on the internet on two topics:1. The futility and unsustainable nature of the constant quantitative growth economic model leading to all of our present economical and financial woes, including the global debt burden,2. The global, integral and totally interdependent nature of our present day human system, necessitating full integration, and mutual, considerate and equal planning and decision making.Only by addressing the core issues, the root of our problems can we achieve meaningful and sustainable solutions.

More recent articles? -- That's an understatement if I ever heard one. At the break neck speed of world-wide restructuring at present, one needs blow by blow commentary -- along with the big picture.

The interdependence and integration that you are referring to are happening at such a frightening rate that our perusal of old intrauterine literature will be of little value as the baby now heading down the birth canal, is born before our very eyes!

Well, the federalization of war debts back then wasn't exactly popular and thought of to favor only speculators who bought up the debt on the cheap. Jefferson won 1800 campaigning on these lines.And it didn't last long and the states were back up to the hilt in debt and some had to default.Really a modell for Europe?But raising tariffs to pay for it all may turn out to be popular today as well.

I've been trying to get in touch with the folks at Sciences Po for my upcoming semester there. Given the lack of response I take it they're enjoying their August vacations and hopefully reading some of these books.

Alberto Bagnai, ET AL
want the Greek government to abandon the euro – and all other eurozone members to follow suit.

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